I am proud to be with you tonight on the occasion of my induction into the Spanish Royal Academy of Economic and Financial Sciences. I am deeply honoured by this distinction; not only because I am joining an institution which has more than 250 years of history and whose members include the most prestigious economists; but also because I've been invited to join as Corresponding Academician for my beloved country, Mexico. Thank you so much!

I would like to take this opportunity to discuss an issue that is increasingly important for Spain, Europe and the world at large, namely the competitiveness challenges that the European economies are facing. Many people see this issue as crucial for Europe to overcome this crisis and regain a path of growth and job creation.

My talk will be based on the longer paper you have in English, which also contains a number of figures and the analysis on which these remarks are based.

Europe's economic performance and competitiveness: recent trends

As we Spanish speakers say, let's take the bull by the horns. Following a lengthy crisis lasting about five years, Europe, and particularly the Eurozone, is facing a twin growth and productivity slowdown. This has had a very severe impact on employment. In September, the Eurozone unemployment rate rose for the 16th straight month to a level of 11.6%.

This twin slowdown is also undermining Europe’s export capacity. European goods and services have started to lose ground on international markets, while the emerging economies have been increasing their presence in new markets and have moved up their export value chain. This is not just an outcome of the crisis. Even before the crisis, the economic performance of most European Union (EU) countries was already inferior to that of the best-performing OECD countries, and their underlying growth was very weak.

One of the key elements in the erosion of competitiveness and economic dynamism in Europe is the absence of robust, sustained, and homogeneous productivity growth. Recent productivity trends in the EU display major contradictions. France, for example, is well above the Eurozone average in terms of productivity per hour worked; but, the French work shorter hours than their peers in other countries. In contrast, the productivity of German workers is lower, but they work longer.

Although some countries have made quicker progress, productivity growth in the Eurozone over the last decade has been below 1% per year. This is less than the average increase in the OECD, Japan and the United States. Although productivity is generally lower in the southern countries of the Eurozone and in central and eastern Europe, over the last decade these countries have been catching up quickly.

Another crucial factor has been the emergence of widely divergent unit labour costs in Eurozone countries, which basically reflects different wage behaviour. While in Germany pay has increased moderately, resulting in flat unit labour costs, in the peripheral countries (Greece, Italy, Portugal and Spain), wages have risen despite moderate, or even flat, productivity growth. This difference has been a key factor driving the trade and current account imbalances which have accumulated in the Eurozone since its creation, and which are at the root of the current crisis.

Diverging patterns of unit labour costs have affected the real effective exchange rate of Eurozone countries, penalising countries such as Greece, Italy, Portugal and Spain, where wages have risen more quickly. Among other things, a rising real effective exchange rate undermines a country's external competitiveness and its capacity to maintain (or increase) its exports.

Compared to other OECD countries, the loss of export market share has been particularly acute for a number of countries in the Eurozone. The United Kingdom has also seen its share of export markets decline considerably, although it has gained a degree of price competitiveness thanks to the depreciation of the pound sterling.

The OECD estimates that Eurozone labour productivity will grow by 1.6% per year between now and 2025, which would be close to the 1990-2010 average. Low productivity growth has major implications for the potential growth of European countries, since population ageing makes productivity growth essential to compensate for the shrinking of the working-age population. In the medium term, this will lead to slower potential economic growth than in previous decades, unless productivity grows faster.

Reforms to restore competitiveness

To foster more dynamic productivity growth and raise competitiveness, with a view to achieving stronger, cleaner, and fairer growth, the European countries need to implement an ambitious structural reform program. According to our analysis in the OECD, by implementing reforms to revive long-term growth many European countries could raise their GDP growth by several percentage points over the next decade, particularly those with the severest competitiveness problems. Many of these reforms could produce positive effects in just a couple of years.

I would like to highlight some of the reforms the OECD considers most important:

1. Completing the single market

One of the EU’s most powerful tools for stimulating growth and competitiveness is the deepening and the completion of the single European market. The functioning of the single market largely defines the capacity to promote competition and internal trade in products, services, and capital, as well as foster integration and worker mobility. Although substantial progress has been made on economic integration, many activities are still organised around relatively small national markets, particularly in the service sector.

Greater market integration generates comparative advantage through specialisation. It also stimulates competition, rewards quality, and promotes innovation. Consumers benefit from a wider variety of products at a lower price, since production costs are reduced and efficiency is rewarded. Recent evaluations suggest that, during its first two decades, the single market helped increase the EU's GDP by 2%, and employment by 1.5 %.

2. Increasing competition in national product markets

While a better-integrated single market would enhance competition between firms, national policies will also be needed to relax the excessive regulation of product markets in many countries. Greater competition in the product market is essential to support innovation and productivity. For example, while the overall restrictiveness of regulation is below the OECD average in Germany, Italy, and Spain, the retail sector in those countries and the professional services sector in Germany and Italy are strictly regulated.

3. Supporting innovation

Innovation is crucial to productivity enhancement. With some non-OECD economies gaining an increasing share of global research and development (R&D) activities, stepping up innovation in Europe is crucial for promoting competitiveness and achieving sustainable growth over the longer term. Reaching the Euro 2020 strategy aim of investing 3% of GDP in R&D should be a priority.

Germany, which spends 2.8% of its GDP on R&D, accounts for about 30% of the total R&D of the EU's 27 members. The challenge of innovation is particularly urgent in the southern European countries, particularly in terms of promoting the knowledge economy and so-called “knowledge- based assets”.

4. Investing in human capital

Quality education is the cornerstone of competitiveness. A highly-skilled labour force is crucial for boosting productivity and growth in the long term. Apart from training and preparing the new generations in the skills that will be needed by the economy of tomorrow, education plays a key role in reducing social inequalities.

Despite the progress that has been made, improving the quality of secondary and higher education is unfinished business in numerous European countries. In many cases, performance in reading, mathematics and science among 15 year-old students evaluated by our PISA report is still below the OECD average. In addition, while the impact of demographic ageing varies across countries, the group of school leavers from which higher education traditionally recruits is shrinking.

5. Improving the functioning of labour markets

Adapting the labour market to a constantly changing economy is essential to continue creating more and better jobs. An efficient, inclusive and well exploited labour market provides an essential platform for boosting economic growth and productivity, by channelling investment in human capital to where it can be used most effectively.

Labour market policies are also important to ensure that growth is more inclusive and generates opportunities for all. Many European countries need to overcome the excessive dualism of their labour markets, in which strict protection for workers on permanent contracts contrasts with the situation of temporary employment, which very often bears the brunt of restructuring at times of crisis.

In this regard, wage-setting mechanisms should reflect productivity trends, since this is likely to be crucial for restoring competitiveness. The experience of OECD countries suggests that decentralised wage bargaining can help wages to better reflect productivity gains. Several Eurozone countries, such as Spain, Greece and Ireland, have already taken major steps in this direction.

6. Reforming tax system to promote growth

There is also room for improvement in the fiscal domain. For example, many European countries maintain relatively high tax wedges on labour incomes. Reducing this burden is another way to promote growth and encourage employment and investment. In the current context of fiscal consolidation, these measures need to be applied in a revenue-neutral fashion — by shifting the tax burden away from labour income and on to indirect taxes, taxes on property, or environmental taxes.

These are just a few of the structural reforms we consider strategic for promoting competitiveness in Europe. It is crucial to identify these and other lines of action. But the greatest challenge is not knowing "what" to do, but "how" to do it.

The importance of political economy: the devil is in the "how"

Political economy considerations are fundamental for successful implementation of the reforms, and governments need to take these into account when designing structural changes. Policies to stimulate competitiveness should go hand-in-hand with a more global programme to raise the population’s living standards, foster integration and social justice, and conserve the environment.

At the OECD, we have identified a number of key elements in the capacity of governments to implement high-calibre reforms. Let me mention seven of the most important:

A clear electoral mandate;

Substantial cohesion around the need for reform;

Robust government leadership;

Sound analysis of existing shortcomings and the positive effect of the measures to be implemented;

Effective communication to the population of the positive long-term impact of the reforms;

Firmness and perseverance in the face of domestic and external pressures;

Patience and a long-term vision, since the reforms will not produce their effects from one day to the next.

Economic crises, such as the one we continue to suffer from, create exceptional opportunities to promote and approve far-reaching reforms — mainly because they reveal the unsustainable nature of the status quo, reduce risk aversion, and make it easier to accept change. Nonetheless, the reforms need to be well-designed to achieve the best trade-off between their short-term effects and long-term benefits. Otherwise, there is a risk that "momentum" and support will be lost along the way.

It is therefore advisable to prioritise the reforms in sectors where the effects will be felt more immediately, such as measures that foster job creation. The reforms most likely to produce negative short-term effects should be adopted gradually to ease those impacts and guarantee the net long-term benefit.

The OECD is working intensively to support the efforts of European governments to promote wide-ranging structural reforms. Through rigorous analysis, based on our cumulative experience in identifying best practices, we are promoting an approach that recognises the multidimensional nature of the challenges, based on knowledge exchange, the setting of standards and the so-called “Peer Review”.

Our advice also aims to identify complementarities between the different public policies, so that the effect and benefit of the different reforms are mutually reinforcing, the potential adverse effects are minimised, and synergies are exploited to the maximum.

To improve this analytical and advisory capability, we have launched an initiative called New Approaches to Economic Challenges, which aims to revisit our models and basic thinking in the light of what we have learnt from this crisis. In the same spirit that inspires the raison d'être of this Academy, this new initiative responds to the need to review what has failed and see how we can contribute to the progress and improvement of economic science, exposing our activity to new thinking, evidence, and sources of inspiration.

Ladies and gentlemen:

"Innovate or die" — that is the choice facing not only our discipline, but also our economies. As I've tried to express throughout my talk, reforming to be competitive in Europe is not a matter of choice, but a necessity. It is not only a question of encouraging growth and creating more and better jobs, but of underpinning the continuity of the most successful economic integration process in history and restoring societies’ trust in government and its institutions, in firms and banks, and in market economies and democracy generally as systems of economic and social progress.

Thank you very much for your attention; and, of course, I am extremely grateful to you for admitting me into this noble Institution.